On degrees of moneyness [fluff piece]

The main idea: money can be placed in three tiers depending on whether it has or lacks neutrality and a responsive supply.

0. Posts on this blog are ranked in decreasing order of likeability to myself. This entry was originally posted on 14.01.2025, though it is a much expanded first part of my first post from September 2021. The current version may have been updated several times from its original form. 

0.1 This post is a fluff piece, containing analysis and commentary but no proposed solution to some issue. I try to keep this sort of stuff to a minimum as commentary for commentary’s sake is not the point of this blog. 

1.1 The economy under the division of labour is a massive and massively complex system with immense degrees of freedom. Only money, an emergent computer of comparable capability, is equal to the task of daily optimising resources such as to fulfill demand to the greatest degree possible. Money alone can run such calculations at any reasonable speed.

1.2 These calculations need to be run in the moment as well as in time. It is extremely hard not to mess monetary calculations in time, but accounting relies on this being the case to an acceptable degree. Was value created or destroyed? Need a true standard in time to answer that. 

1.3 Now, not all money is equal to the task. Indeed, so hard is to achieve this standard, that we can in principle model the degree to which any monetary standard approaches the ask as below.

2.1 At its most basic, money need only be good enough to solve the problem of the double coincidence of need, without which solution division of labour cannot propagate.

2.2 To do so, it needs to have the capacity not to spoil immediately, be transferable with some ease, be divisible, have some pre-monetary use, and be of a locally and temporally constrained supply. Plenty of goods fit the bill, and indeed plenty have been used as money at this capacity level, a Tier 1 standard. Here’s where you find your seashells, cattle, .22LR, prison cigars, etc. 

2.3 Tier 1 standards serve as medium of exchange only and may well be the first to actually emerge in history, as per Mises’ regression theorem. Their only job is to be the Schelling Point everyone agrees to have in their pockets when heading out to the market. No one need actually hold or save in this standard, just buy it now and sell it with little delay to get the tools or whatnot they need whilst working as bakers. We may call this the hot potato standard to get the point across. 

2.4 Given this, the degree to which this standard’s supply varies is of limited concern. As long as we’re not talking about literal pieces of paper that can be issued instantly, even pretty large supply infusions will be fine as long as one still has the ability to buy now and sell a bit later with limited changes in price being suffered. Whether prices a week from now are double of half today’s matters little at this stage.

2.5 This common standard hides a lot of variation in the degree to which money is actually held, with the specie gold standard being a high example of it. I myself have thought of a cryptocurrency that would conform to a (hopefully high) Tier 1 standard. 

3.1 This standard enables the division of labour but is terrible at facilitating economic calculation, to do which you need the price of money to be stable. 

3.2 The price of money is not the interest rate, but its purchasing power: how much “stuff” does a unit of currency buy you. When this price falls with time, you have inflation. If it increases with time, deflation.

3.3 We’ll come back to the details of why stable prices are required for proper calculation, but for now suffice it to say that achieving this requires changing the monetary supply, which in turn opens up the question of dilution: if someone is increasing the supply of money, the other holders are taking a loss, and vice versa if the supply is decreasing.

3.4 Note how dilution or inverse dilution is not linked to the demand for money, just to its actual, nominal supply. Any increase in monetary supply will dilute existing holders, even if warranted from the point of view of ensuring as stable price against a growing demand.

3.5 And so, we have our Tier 2 monetary standard, which includes all requirements from Tier 1 and well as the need for money to be neutral, i.e. such that all changes in supply cannot dilute or inverse dilute existing holders. 

3.51 All public complaints about inflation link to the lack of money neutrality: a Tier 2 standard would fully satisfy all these concerns, hence why most think that Satoshi finished the job in 2008. But he didn't, we still have one Tier to go. 

3.6 Remaining at Tier 2, by far the easiest way for money to be proportional as per this standard is for its supply to be strictly limited and unchanging. We may call this special case a Tier 2 Half standard, with Bitcoin being such a standard.

3.7 The more involved Tier 2 Full standard which requires supply changes to be proportional may be approximated by some stock subject to buybacks or splits, or by some cryptocurrency with a central burning mechanism in place. 

3.8 One can now see a relatively easy way for a Bitcoin-like cryptocurrency to progress from Tier 2 Half to Tier 2 Full standard, by just awarding a fixed interest to all holders, with the rate chosen such as to approximate one's estimate of the long-term growth of the economy. Say, in Milton Friedman's honor, this is set to 5% p.a., suitably translated to a per block basis. 

3.9 A Tier 2 standard may be now safely held / saved in, as the fear of dilution is eliminated. The price of a unit may still crater one week to the next in term of real goods due to oversupply, but all holders will see the same gain in number of units, so the effect will be none. Indeed, it will be as if the supply doesn’t change at all, and the market cap of this standard will increase with demand. Tier 2 standards thus serve as medium of exchange and stores of value at the same time.

3.10 Note though that, even if it may be safe to save in this standard, it may be terribly unsafe to invest in it, as issuing out loans to be paid back in terms of a currency the unit price of which fluctuates in real terms may prove ruinous to the borrower or lender. Note how there’s no loans denominated in Bitcoins. 

4.1 So, a Tier 2 standard still fails to allow for economic calculation and a useful unit of account. But why is it key that the price of money remain stable in time?

4.2 A deflationary monetary standard in which money supply grows slower than demand makes it look as if companies lose money where they may not have: it sets a hurdle over which folks have to jump before they are allowed to see a nominal monetary gain. An inflationary standard, on the other hand, makes it look as if firms make money while sitting on ass.

4.3 Alternatively, if you just sit on a pile of deflating currency, you will make a real profit as measured in your ability to buy real goods. Just ask the HODLers. But you have contributed nothing to the economy’s ability to produce such goods. The value you reap is simply a calculation error due to the deflationary nature of the currency.

4.4 Likewise for sitting on a pile of inflating currency, whereas one suffers a real loss every day, although they have done nothing to hurt the ability of the economy to create goods. Again, an error. 

4.5 And here we come to the supremely difficult task of a true, Tier 3 monetary standard: its ability to respond to changes in monetary demand. When more money is required, this standard is able to create more money (in a neutral fashion though, as we still require all that Tier 2 could achieve), or destroy it when demand falls. Tier 3 money can now serve as a medium of exchange, store of value and unit of account at the same time.

4.6 There’s a myriad mechanisms that have attempted to solve this requirement, from the historically successful fractional reserve system, to inflation targeting and who knows how many others. One may try to target NGDP, an index of commodities or, as I have, attempt to create a system such that everyone can issue as much money as they wish, but face a cost to do so. 

4.7 Be it what it may, a Tier 3 standard and only a Tier 3 standard makes it finally safe to invest and thus allows for true profit-and-loss calculations, doing all that money is required to do.

4.8 Note how, although hard to achieve, a Tier 3 monetary standard is at least easy to recognize when incumbent: if consols (instruments that let you borrow once and pay back forever a known sum) trade, you have a stable standard to a reasonable degree.

4.9 The classic gold standard (fractional reserve notes issued by competing banks atop a common gold and/or silver base) has achieved this. Let’s see if others – such as yours truly - can do so as well.